Amortization has two main meanings: spreading the cost of an intangible asset (like a patent) over its useful life, and spreading a loan's repayment over scheduled payments. For assets, the formula is (Cost − Residual Value) ÷ Useful Life. It's the intangible-asset cousin of depreciation.
What Is Amortization?
Amortization has two applications in finance:
- For intangible assets: spreading an asset's cost over its useful life.
- For loans: spreading repayment over time, gradually reducing the balance.
(Fun fact: "amortization" comes from the Latin admortire — "to kill" — because you're killing off an asset's value over time.)
Amortization of Intangible Assets
This applies to assets like patents, copyrights, trademarks, goodwill, and (in some cases) software.
Annual Amortization = (Asset Cost − Residual Value) ÷ Useful LifeFor intangible assets
Worked example
A tech company buys a patent for $100,000 with a 10-year useful life and $0 residual value:
($100,000 − $0) ÷ 10 = $10,000 per yearAmortized over 10 years
Amortization vs Depreciation
| Amortization | Depreciation | |
|---|---|---|
| Applies to | Intangible assets | Tangible assets |
| Examples | Patents, copyrights, software | Cars, machinery, buildings |
| Concept | Both spread an asset's cost over its useful life | |
Loan Amortization
For loans, amortization is paying off the balance with regular payments covering both principal and interest. Each payment shifts more toward principal over time:
| Payment | Principal | Interest | Remaining Balance |
|---|---|---|---|
| 1 | $800 | $200 | $19,200 |
| 2 | $810 | $190 | $18,390 |
| 3 | $820 | $180 | $17,570 |
The principal portion rises while the interest portion falls — that's amortization in action.
Why Amortization Matters
- Intangibles: matches an asset's cost to the revenue it generates, affects reported profit, and is often tax-deductible.
- Loans: gives borrowers a clear repayment schedule and shifts the balance from liability toward equity over time.
Amortization FAQ
How do you calculate amortization?
For an intangible asset: (Cost − Residual Value) ÷ Useful Life. A $100,000 patent over 10 years amortizes $10,000 per year.
What's the difference between amortization and depreciation?
Amortization applies to intangible assets (patents, software); depreciation applies to tangible ones (machinery, vehicles). The method — spreading cost over useful life — is identical.
What is loan amortization?
Paying off a loan through regular payments that cover both principal and interest. Early payments are interest-heavy; later ones are principal-heavy, until the balance reaches zero.
Is amortization a cash expense?
For assets, no — it's a non-cash expense, like depreciation. For loans, the payments themselves are cash, but the amortization schedule just describes how each payment splits between principal and interest.
